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Indian Rupee - Worst performing Asian Currency in 2018?
On Thursday, June 28, 2018 the Indian Rupee plummeted to Rs 69.01 against the US dollar—its lowest level ever. Its previous all-time low was Rs68.86 which it hit in November 2016. Till now in 2018, it has already lost over 8%, making it Asia’s worst-performing currency. This makes the Indian Rupee the worst-performing currency in Asia this year.
The main triggers for the fall includes rising crude oil prices, a widening trade deficit, and more foreign investors pulling out of the market.
India's Current Account Deficit - the elephant in the room!
The current account deficit is a measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the goods and services it exports. The current account represents a country’s foreign transactions and, like the capital account, is a component of a country’s balance of payments. A nation which has a large Current Account Deficit will have its currency battered.
India has a large current account deficit among most of the major economies in the Asia-Pacific region. China ran a huge current account surplus of about $164.8 billion for 2017. While many countries in the region run current account surpluses, others have narrower deficits than India.
The chart shows this fact:
For India, imports of Crude Oil and gold are the major contributors of CAD.
In 2013, when the rupee weakened past the Rs 68/USD mark for the first time, oil was near USD 110/bbl. But, it is not as if the oil has been the only villain. During this period, the current account deficit (CAD) was seen testing 3.6 percent putting pressure on the rupee. The pressure on CAD, by way of imports, was largely due to gold, apart from oil.
The curbs imposed by India on imports ensured that gold's pressure on CAD was also solved. The government has been steadily upping the import duty on gold with a view to making its import unattractive. While this might indeed discourage investment in gold, there is no guarantee that the craze for gold for ornamental and ostentatious use would recede, given the social mores obtaining in large parts of the country. Nothing short of a physical ban on import of gold, therefore, would stop the hemorrhage of precious foreign exchange. The resultant loss of import duty revenue would be more than made good by the steep reduction in the current account deficit.
India's crude oil imports is a "bomb":
India is a net importer of oil and every $10 per barrel increase in price could worsen its current account and fiscal balances by 0.4 percent and 0.1 percent of GDP, respectively, Nomura analysts estimated. That could shave around 15 basis points off the country's growth, the analysts have quoted.
The Reserve Bank of India baseline scenario assumes crude oil prices (Indian basket) to average around $68 a barrel in FY2019. The rising inflationary risks can push RBI’s rate hike which in turn will hurt growth.
India has till date not been able to make a major breakthrough in finding oil and gas. Hence, India is vastly unexplored in terms of natural resources. Companies want to invest but there is no cheap financing available, the risks are too high to make a commercial discovery. The recent policy reforms in tge Oil and gas exploration, the International Solar Alliance, Electric Vehicles and the thrust on renewable energy like solar, wind and tidal are to address this fundamental disadvantage of being a net importer of oil.
There were reports that the government had asked oil marketing companies (OMC) to absorb the impact of the rise in crude prices to the tune of Rs 1 per litre. Though this has been denied by the government and the OMC, the market still fears that the government may attempt to do this discreetly. Though only liquefied petroleum gas (LPG) and kerosene oil are subsidised now, this subsidy will balloon as the rise in LPG and kerosene prices won’t be passed on to consumers in an election year.
For each $1 increase in crude price, OMC raise petrol and diesel prices by around 40 paisa—a hike of around Rs 2 for every $5 dollar increase in crude. If this increase is not allowed, their retail margin will suffer.
Why crude oil is traded in US Dollar? Bid adieu to Bretton Woods System
In order to buy crude oil from the OPEC countries, any nation has to pay in US Dollars. In 1971 United States unilaterally terminated the conversion of US dollar to gold, bringing an end to the Bretton Woods System, which carried with it a risk of huge decrease in the demand of US dollars.
Oil being one of the core infrastructural needs, no country can live without it. US was wise enough to identify it, and in 1973, they created a concept called "petrodollar".
In 1973, a deal was made between Saudi Arabia and USA, as per which any country willing to purchase oil from Saudi Arabia must pay in no other currency than US dollar. In return US offered Saudi Arabia weapons and military protection to their oil fields. This deal further got extended and by 1975, all of the OPEC nations (these nations comprise of more than 81 per cent of world's crude oil reserves) agreed to sell their oil ONLY in exchange of US dollars.
This deal restored the artificial dollar demand.
Consequently, any country, in order to buy oil from the OPEC countries, needed to get their currency exchanged from US dollar, or increase the export to US in an attempt to gain more dollars. Trading with US also benefited the US as there is a need to balance trade deficit between the nations.
Is it the beginning of the end of US Dollar dominance?
At present, the dollar comprises about 64% of world reserve currencies (with the next largest being the euro at 20%). One-third of global GDP is generated by countries that fix their currencies to the dollar and 85% of foreign exchange trading involves the U.S. dollar. By contrast, the RMB comprises about 1% of global reserves. Despite recent turmoil in the U.S. stock markets due to political volatility, the U.S. is still considered the strongest economy in the world. While that doesn’t mean that its hegemonic status will last forever, China will have to prove to the world that it is not only politically and economically strong, but that it is stable and profitable. When that time comes, China will be able to increase the role of the RMB in the oil trade.
Iran dilemma for India - More trouble in form of crude oil import bill:
Iran is a major exporter of crude oil to India after Saudi Arabia and Iraq. According to a Bloomberg report, Iran’s oil exports to India surpassed that of Saudi Arabia’s and the country emerged as the second-biggest oil supplier to India in the month of May 2018. India’s crude oil imports from Iran surged 35% in May to 7.71 lakh barrels a day, Bloomberg reported.
India, which imports over 80% of its oil, is attracted to Iran’s crude largely due to geographic proximity that can save on shipping costs, as well as the favourable financial terms offered by Iran, including the longest credit period among all of India’s suppliers, a Bloomberg report said. Iran has supplied about 18.4 million tonnes of crude oil from April 2017 to January 2018.
The United States has told all countries including which includes India, to restrict crude oil imports from Iran by 4 November, 2018. According to a PTI report, the countries carrying out any transaction with Tehran (capital of Iran) beyond the said timeline are likely to face sanctions as would be “zero” waivers to any country.
Foreign Investment Inflows, Round-tripping and Tobin Tax:
FPIs (Foreign Portfolio Investors) have emerged as net sellers in the first two months of FY19 and have already sold-off around Rs 14,000 crore worth of equity and debt securities in June 2018. When the FIIs exit, the resultant demand for dollars dents the exchange rate.
There is a strong justification for Tobin tax on repatriation within, say, six months of inward remittance. A Tobin tax, suggested by Nobel Memorial Prize in Economic Sciences Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another. Tobin's original tax was intended to put a penalty on short-term financial round-trip excursions into another currency.
It is now common knowledge that a substantial part of FII investment is laundering of ill-gotten money by Indians through the process of round-tripping. That such investments are used to prop up the shares of companies promoted by those indulging in round-tripping.
Automatic route to ECB to blame?
The automatic route to external commercial borrowings (ECB) under which a company, irrespective of its pedigree, can borrow upto a whopping US $700 million a year has been responsible for the mindless borrowing abroad based on low dollar interest rates. The RBI has found that as much as 80 percent of such borrowings are unhedged, so much so that with a steadily depreciating rupee, the repayment and interest obligations have burgeoned, wreaking havoc both on individual companies and the larger macroeconomy.
The solution: Make in India.
India should look to decrease its over reliance on imports. This happens when there is indigenous manufacturing in India. There is a need for a big reform in this front. There is Make in India, but that has not been a very dominant force given the poor competency of the skilled workers in India. Reform in education is also necessary to improve the engineering and the manufacturing skills of India. Also, there is a need to decrease the appetite for vehicles and gold to address the gaping CAD.
Also Read: RBI Monetary Policy, June 6th, 2018